The Regulation of Traffic, Tolls and Tariffs

• Regulatory Processes
• Tariffs
• Traffic
• Toll Regulation
  • Cost-of-Service Regulation
  • Negotiated Settlements
  • Incentive Regulation
  • Complaint-based Regulation
• Toll Design
• Tolls on an Interim Basis
• Surveillance Reporting
• Accounting

The National Energy Board (NEB or the Board) is an independent federal agency whose purpose is to promote safety and security, environmental protection and efficient energy infrastructure and markets in the Canadian public interest¹ within the mandate set by Parliament in the regulation of pipelines, energy development and trade. The NEB regulates the construction and operation of pipelines that cross international or provincial borders, as well as tolls and tariffs on those lines.

1. The Canadian public interest refers to all Canadians and to a balance of economic, environmental and social interests that change as society's values and preferences change.

From the perspective of promoting efficient energy markets, the NEB is able to protect the public interest, in part, by regulating the pipeline companies to ensure that tolls charged for transportation services are reasonable. Regulation is also necessary to ensure there is fair access to pipeline services, appropriate services are offered and there is no discrimination in charges or transportation services.

For the pipeline company, regulation provides a framework in which the company can recover its investment and have sufficient financial strength to allow it to attract capital to build and maintain its system. Regulation also provides a structure for the terms of use of the pipeline which can be adjusted over time as circumstances change.

Regulatory Processes

The NEB is a court of record and its decisions and reasons for decision are public documents. Applications and complaints concerning traffic, tolls and tariffs may be filed with the Board at any time. When examining tolls, the Board has the discretion to determine whether an oral or written public hearing is warranted. The Board's practice is to seek input from interested parties before making a decision on an application or complaint.

Tariffs

A pipeline company cannot charge a toll unless it is included in a tariff filed with the Board or approved by an order of the Board. This tariff may also include terms and conditions with respect to a shipper's access to the pipeline, as well as the rights and responsibilities of both the pipeline company and shipper once service begins.

Traffic

There are two different types of pipeline carriers - common carriers and contract carriers.

A common carrier must accept all product offered to it for transportation. When there is insufficient capacity for the volumes offered and unless the Board has approved an alternative methodology, the pipeline company allocates its available capacity to accommodate all shippers. The Board ensures that access to and allocation of capacity occurs on an equitable basis.

Typically, oil pipelines (i.e. pipelines which carry oil, natural gas liquids and petroleum products) operate as common carriers although some oil pipelines are now requiring long-term take-or-pay agreements prior to construction. To date, all have maintained some capacity available for common carriage.

Contract carriers require a contract before accepting a product for transportation. Natural gas pipelines are operated as contract carriers. A gas pipeline company's tariff may contain conditions for open season and access procedures, the minimum duration of contracts, renewal requirements and the bidding process used to secure interruptible service. In this way, gas pipelines companies provide equal and non-discriminatory access for all shippers. As well, the Board has the authority under the Act to direct companies to provide service for a shipper.

In 1996, the Board obtained jurisdiction over interprovincial and international pipelines which carry commodities other than oil or natural gas such as steam, brine, chemicals, pulp or coal slurry, alone or in combination with hydrocarbons. To date, all of these pipelines have been designated as Group 2 pipelines and are regulated on a complaint basis. (See section on complaint-based regulation below.)

Toll Regulation

Toll regulation aims to strike a balance between the interests of shippers and the pipeline companies. Until the mid 1990s, the predominant method of regulation was cost-of-service. Under this approach, companies came before the Board, often annually, to determine the amount of revenue the pipeline company was allowed to recover through its tolls. Proceedings to determine the cost of service and tolls are generally adversarial and time consuming, requiring legal counsel and presentation of expert witnesses.

For some time, the Board has been concerned with reducing the cost of regulation and developing alternatives to the cost of service model. Through initiatives such as its Guidelines for Negotiated Settlements of Traffic, Tolls and Tariffs and its complaint-based regulation, the Board has been a leader in developing or encouraging alternatives to the traditional cost-of-service methodology. In the process, the Board has facilitated and supported consensus building between pipeline companies and their shippers.

Cost-of-Service Regulation

Between 1970 and 1995, the Board used the cost-of-service approach almost exclusively for setting tolls. A toll adjustment requires that a company file a toll application with the supporting documentation specified in Guide P of the Board's Filing Manual. The Board then establishes a proceeding to allow input from interested parties. Afterwards, the Board issues a decision approving final tolls.

Under this cost-of-service methodology, a pipeline company's tolls are set to provide investors with the opportunity to recover costs and earn a reasonable return on their investment in the pipeline. To set tolls, the cost of service and throughput are forecast for a forward test year. The cost of service is made up of operating expenses, depreciation, return on capital, and income and other taxes. The Board allows, but does not guarantee, a pipeline company the opportunity to earn an approved rate of return.

A company may not recover costs from a previous year without prior approval. As a rule, the Board only allows a company to defer the recovery of costs to another year when they are beyond a company's ability to control or estimate accurately, such as tax changes and amounts in dispute before the courts. Deferred costs are then subject to scrutiny before being included in another year's cost of service.

The return to be allowed on the rate base can be a contentious matter. Because the rate base is financed with both debt and equity, appropriate proportions for each and their rates of return must be determined. Debt tends to be a lower cost source of financing than equity, in part because it is tax deductible and also because debt holders are paid before funds are allocated to shareholders. Equity investors and shareholders must be fairly compensated for the risk they assume as owners of the pipeline.

In determining the appropriate rate of return, the Board considers whether:

• the utility can attract capital on reasonable terms and conditions;
• the allowed return is comparable to the return available to other enterprises of similar risk; and
• the financial integrity of the enterprise will be maintained.

In 1995, the Board held a generic cost-of-capital hearing. This initiative was in response to a desire to move away from adversarial proceedings and to avoid the repetition of cost-of-capital evidence. The Board determined appropriate equity ratios for eight companies based upon their business risks. The Board then approved a uniform rate of return on common equity based upon the forecast interest rate for long-term Government of Canada bonds, plus a risk premium. Finally, the Board established a procedure for annual adjustment of the rate of return on equity. This formula, the results of which are calculated and released each December, is known as the ROE Formula or the RH-2-94 Formula.

Negotiated Settlements

Although there had been previous instances of negotiated settlements, beginning in 1995 the Board approved a succession of multi-year negotiated settlements. These agreements generally include incentives to reduce costs and provisions to share savings between the pipeline company and its shippers. In some cases, settlements have included various innovative performance mechanisms.

The Guidelines for Negotiated Settlements of Traffic, Tolls and Tariffs clarify the Board's role and establish acceptable criteria for the settlement process. Generally, the Board wants to ensure that all interested parties have a fair opportunity to participate in the settlement process and that there is a general acceptance of the outcome. The guidelines have facilitated the resolution of specific toll matters and also the development of incentive regulation.

The existence of a negotiated settlement does not limit the authority of the Board. In considering whether to approve a settlement, the Board takes into account the views of all interested parties as well as broader public interest concerns, including potential impacts upon public safety and protection of the environment. The Board either accepts or rejects a settlement package in its entirety. A settlement which is unopposed may allow the Board to determine that the resulting tolls will be just and reasonable without a public hearing.

In the case of a contested settlement, the Board can choose one of three options:

• dismiss the objections and approve the settlement;
• deny the settlement and refer the matter for hearing; or
• approve the terms of the settlement on an interim basis² and then hold a hearing to address the issues raised by dissenting parties.

1. See Tolls on an Interim Basis, discussed later in this document.

Light-handed regulation is one form of negotiated settlement used for gathering and processing facilities on the Westcoast Energy system. Under the Framework for Light-handed Regulation which was established to address unique competitive issues on those facilities, the pipeline negotiates tolls individually with its customers based on a variety of factors.

Incentive Regulation

Incentive regulation has developed mainly through multi-year toll agreements negotiated between pipelines companies and interested parties. These agreements allow both parties to share in the benefits of improved pipeline performance. Frequently, parties agree to a baseline level for costs which may be lower than what the pipeline company may have applied for under cost-of-service regulation.

Under these agreements, the pipeline company has some protection against the escalation of uncontrollable costs and shares rewards for keeping costs below the target level. Similar incentives can apply to efforts by the pipeline company to increase throughput and revenue.

Once approved by the Board, multi-year agreements allow for a more relaxed form of regulation. Each year of the agreement, the pipeline company makes a tariff filing containing new tolls based upon the agreement. After parties have had an opportunity to provide comments on the filing, new tolls come into effect, unless there is cause to examine them further.

Complaint-based Regulation

In 1985, the Board concluded that smaller pipelines under its jurisdiction should be subject to a lighter degree of toll and tariff regulation. The Board divided pipeline companies into two groups:

• Group 1 companies that operate extensive pipeline systems; and
• Group 2 companies that operate smaller pipelines.

There are currently 12 Group 1 companies and approximately 100 Group 2 companies, including six commodity pipelines.

The Board uses a complaint approach for the financial regulation of Group 2 companies. This method of regulation is described in each company's tariff. The pipeline company is responsible for providing shippers and other interested persons with sufficient information to enable them to determine whether the tolls are reasonable. Once filed with the Board, the tariffs containing new tolls automatically become effective. If a complaint is filed, the Board may establish a procedure to examine tolls. In the absence of a complaint, the Board may presume that the filed tolls are just and reasonable. Overall, this approach has resulted in few complaints.

In addition, the Board now uses a complaint approach for tariff filings by certain smaller Group 1 companies that have few shippers when there is general support for this from their stakeholders.

Toll Design

Toll design is the process of deriving tolls for different services and different distances from the cost of service or revenue requirement and throughput or contracted quantities. Tolls should generate sufficient revenue to recover approved costs, and at the same time fairly allocate charges to users in relation to the costs and benefits of different services. The basic principle is user pay.

Toll design divides costs between the various functions performed by the pipeline system, such as transmission and metering, and then determines costs and usage of those functions. Some costs are common to every unit of throughput. Other costs may depend upon variables such as the distance shipped, and still other costs may be unique to a particular type or class of shipper. Finally, some costs may be more appropriately allocated within a geographic zone.

For a new pipeline, the method of tolling can be crucial to its economic viability. The large costs and high risks associated with the construction of a new pipeline have resulted in novel approaches to the setting of tolls. One approach is to keep tolls as low as possible in a pipeline's early years to attract throughput. The Board has also approved the construction of new pipelines which offer market-based tolls when the project sponsors have indicated they are willing to bear the risk of underutilization. Generally, the Board has approved innovative approaches where these are supported by arm's-length agreements negotiated between the pipeline's sponsors and shippers following an open season. In the Board's view, non-discriminatory access requires that service be offered on the same basis, at the same time, to all potential shippers.

With additions to an existing pipeline, there may be toll issues concerning whether expansion costs should be rolled into a single, existing rate base and charged to all shippers equally (rolled-in methodology) or kept separate and charged only to particular shippers (incremental methodology).

In deciding such matters, the Board considers several factors, such as whether the new facilities would be used to provide a new distinct service, which would be used only by certain shippers, or an expansion of an existing service which would provide a benefit to the entire system. Rolling in all costs has the advantage of lower tolls through the spreading of costs among many users; however, this may result in inequitable cost-sharing if the service is not required by, or of value to, all shippers. The Board will look at the specific circumstances when deciding which approach is appropriate.

Tolls on an Interim Basis

The Board can only consider toll adjustments on a forward or prospective basis. In situations where the desired effective date for new tolls will have passed before a decision on final tolls can be made, the Board may issue an order allowing the company to charge tolls on an interim basis until the final toll order is issued. The tolls contained in the final order can then be made effective from the date of the interim order. Refunds or charges which result from the difference between interim and final tolls usually include interest charges.

Surveillance Reporting

Unless specifically exempted, a Group 1 pipeline company is required to file a surveillance report at the end of each quarter based on the Toll Information Regulations. Guide BB of the Filing Manual outlines the information and the format of surveillance reports. These reports provide details of financial performance and explain any significant variations from approved amounts. Through these reports the Board is able to determine whether changes in tolls are likely to be needed and to test the reliability of estimates used to establish tolls.

The Board normally requires all Group 2 companies to file audited financial statements each year. However, Group 2 companies, primarily those with no third-party shippers, may seek an exemption from this filing requirement.

Accounting

The Board's Gas Pipeline Uniform Accounting Regulations and Oil Pipeline Uniform Accounting Regulations establish a uniform system of accounts for Group 1 companies. This provides for the recording of costs in a consistent manner. Group 2 companies are required to keep their accounts in accordance with generally accepted accounting principles (GAAP). The Board can audit a pipeline company's records to ensure the accuracy of filed documents and compliance with the Board's decisions, regulations and other directives.

For more information, please contact:

National Energy Board
444 Seventh Avenue S.W.
Calgary, Alberta
T2P 0X8
Telephone: 403-292-4800
Toll-free: 1-800-89901265
Website: www.neb-one.gc.ca